Finding alternative British dividends after BP payout halt

SarahTurner

LONDON (MarketWatch) -- Oil giant BP's decision to halt dividends until next year has come as a blow for equity income managers in the U.K., but fund managers and strategists say there are appealing, if limited, alternatives in Britain to choose.

Dividend payouts in the U.K. took a hit with BP's (BP)
BP, -0.55%
recent decision to suspend payments, with the oil giant which is battling to clean up a massive oil spill in the Gulf of Mexico accounting for around 12% of total U.K. payouts.

The dividend yield -- calculated by dividing dividend per share payouts by share prices -- on the FTSE 100 index now stands at around 3.22%, according to data compiled by FactSet. That's down from 3.31% at the start of the year.

"It's obviously not good news. It means that the dividend has gone down in absolute terms," said Colin Morton, lead manager of the Rensburg U.K. Equity Income Trust.

But he's not giving up on the firm, preferring to sit on his stake for the time being.

"I have a neutral position in BP and I'm just retaining it for the time being," he said. "I'm hopeful that everything will get sorted out and they will come back with a dividend maybe next February or March," he added.

"The only good news is that the relative yield doesn't change that much for the fund as it affects the whole market. I don't have an overweight position in it so it doesn't really affect my relative yield," he said.

Equity strategists at U.K. brokerage Evolution Securities said: "The sky is not falling. Investors should now focus on the other dividends that are available for distribution, and look for ways to make up their income shortfalls."

The strategists highlighted Royal Dutch Shell (RDSA)
RDS.A, -0.46%
as a possibility for income investors.

The firm, BP's closest competitor, will pay two more dividends through 2010 and the Evolution Securities analysts said "our oils analysts believe that, at present, the dividend is secure."

Morgan Stanley's U.K. equity strategists listed high-yielding companies due to pay dividends at the same time as BP.

These companies tend to be on the defensive side of the market, generating lots of cash but relatively low earnings growth.

There's no shortage of candidates to buy at the moment, said Morton. "It does look quite interesting when you find lots of pretty good stocks yielding 4% to 4.5%," he said.

"We are still exposed to tobacco stocks. British American Tobacco (BATS)
BTI, -2.01%
is yielding about 5%. The other sector we are quite overweight on is utilities. Scottish & Southern and National Grid (NG) are on about 6%," he added,

Morton said that he believes there is an opportunity in income "when you consider that cash is giving you next to nothing at the moment and 10-year bonds yields are giving you about 3.5%."

The Morgan Stanley equity strategists pointed out that U.K. dividends are also boosted by weakness in sterling, as four of the six largest dividend paying firms in the U.K. reporting in U.S. dollars.

"As a rule of thumb, every 10% change in sterling/dollar has a 4% to 5% [opposite] impact on U.K. dividends" they said.

They're forecasting that sterling will weaken against the dollar over the next twelve to eighteen months, averaging $1.42 in 2010 and $1.30 in 2011.

In that scenario, U.K. market dividends would rise by 990 million pounds in 2010 and 3.9 billion pounds in 2011, or 13.6% growth in 2010 and 13.2% growth in 2011, they said.

Still, BP's suspension has thrown into sharp relief that a relatively small number of companies contribute disproportionately to U.K. dividend payouts.

"With the absence of two BP quarterly dividends, Vodafone Group (VOD)
VOD, -1.55%
Royal Dutch Shell and GlaxoSmithKline now account for more than 30% of dividend income in the U.K. market," said equity strategists at Evolution Securities.

Financials used to be big dividend payers but Lloyds Banking Group
LYG, -1.75%
and Royal Bank of Scotland
RBS, -2.49%
for example, are unable to pay dividends until early 2012 after they were bailed out by the U.K. government during the financial crisis.

The small number of companies accounting for a large proportion of payments is making investors increasingly nervous after the BP incident, said Oliver Russ, European income fund manager at Argonaut Capital.

He believes that's led to a renewed interest in European dividend-paying companies, saying he likes telecoms and pharmaceutical firms.

Companies such as Spanish banking group Santander (SAN) could be on the radar for U.K. investors looking for European income, being the owner of three U.K. branch networks and also leveraged to emerging markets.

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